portfolio allocation - All posts tagged portfolio allocation

Janney Montgomery Scott is out with a freshly baked pie chart showing its recommended fixed income allocations, with a recipe that’s been tweaked since the last time around, mainly regarding agency mortgage bonds.

Janney’s upped its allocation to callable agency bonds to 10% from 5%, increased its ABS/CMBS a bit to 5% from 3% citing large return potential and added an allocation to preferreds at a target of 10%. It cut its recommended agency MBS allocation to 15% from 20%, citing tighter post-QE3 spreads, and lowered rate risk by eliminating the 10% allocation to foreign/global bonds. It also made a minor downward tweak to bring its high-grade muni holdings to 20% from 22%.

Amid massive global central bank intervention, and particularly post-QE3, Janney sees four core aquatic-themed choices at this point for the fixed-income investor:

Take the gains, stay onshore, go to cash, and lock in 0% nominal returns

Take the gains and reinvest in real return assets such as TIPS and other inflation-indexed holdings hoping for an eventual rising tide

Continue to load the boat on risk assets, just like the central banks are hoping we’ll all do.

The correct answer? Load the boat. From Janney:

As uncomfortable as it may be to take the Fed’s trail of breadcrumbs as the unwavering route, the most realistic option for fixed income portfolios is to remain on the pro-risk path, with an above-average allocation to corporates in particular. This preference stems from an elimination of (1), (2), and (3) as realistic options. At present, cash is, ironically, a surefire way to lose money, as inflation in the 2.0% range is easily overwhelming returns on ultra short term assets. Real return assets such as TIPS are meanwhile suffering from the low real rates and deteriorating inflation expectations. When it comes to option (3), buying government debt, current yields leave little room for error—the market impact of a 22 basis point increase in yields over twelve months will wipe out a full year’s worth of income for a ten year Treasury. While we maintain a benign interest rate forecast, it’d be foolish not to acknowledge that our margin of error is at least 0.25% per year. That leaves portfolio option (4).

By process of elimination, we’ve come to the conclusion that an above-average allocation to risk assets is going to be the strongest portfolio structure as credit spreads grind tighter in a post-QE3 world.